Is rent-to-own a viable path to home ownership?
Rent-to-own offers the opportunity for homeownership to those with low savings and bad credit, but the path is costly and many don’t make it.
Typical rent-to-own deals are a renter’s path to poverty. For instance, renting furniture often requires the renter to pay many times the actual value of the item, and the only reason anyone enters into these agreements is because they have no savings and no better alternative. This kind of imbalance in the relationship between renter and landlord is ripe for abuse (or profit).
The lure of a rent-to-own deal is the ability to enjoy the house while saving money to buy it. It has the potential to be a major path toward home ownership, assuming the path isn’t so costly that nobody can complete the journey.
In Monday’s post, REO-to-rental companies helped many former owners stay in their homes, I proposed giving the former owners who rent their properties the opportunity to buy it back. Most potential first-time homebuyers today are either young people with too much debt and too little savings or a former owner with bad but recovering credit (probably also low on cash).
Although the minimum down payment is only 3% at the GSEs or 3.5% at the FHA, many people are unable to save this much, often because they spend too much on rent. For those with low savings or poor credit, a rent-to-own deal allows them the joy of the use of their future home while also providing them time to get their financial house in order. The advantages of this relationship are prompting its return.
Investment firms bank on giving renters an option to buy
Wall Street firms have found a new way to profit from consumers with blemished credit who can’t qualify for a mortgage: let them rent a home first with the option to buy it later.
Rent-to-own programs, once run mainly by small operators, were popular with cash-strapped consumers during the 1990s. They faded a decade later when easy lending made it possible for almost anyone to buy a home with no money down, but with lenders setting a higher bar, they are making a comeback.
For investors, it is a chance to profit off the recovering housing market. Consumers get a chance to lock in a home before they have the money together for a down payment. But the price may be higher rent in the interim and a higher purchase price the longer they wait to move from renting to owning.
This is a good synopsis of why some form of this deal could become very popular over the next ten to twenty years. The Millennials generally have large debts and low savings, so they are out of the home ownership game until their balance sheets improve. A rent-to-own program allows them to secure their family home before they can afford to buy it under terms that won’t imperil themselves or the broader economy.
Here’s how Home Partners’ program works. A consumer teams up with a real-estate agent to select a home in one of Home Partners’ approved communities, which tend to be suburban locations with strong school systems and with homes priced between $100,000 and about $725,000. Home Partners buys the home and leases it to the consumer, who has the right to purchase the home from Home Partners within five years in most places. During the renting years, the consumer is expected to repair his or her credit and save for a down payment, but the longer they rent the more they will pay to acquire the house.
For example, a house shown on Home Partners website has a list price of $449,975 in Chula Vista, Calif. The family that agrees to rent that house from Home Partners has the right to purchase the home for $472,035 after one year and would have to pay $573,762 if it waited five years before purchasing, a markup of 28% from the initial list price.
The monthly rent on the property would start at $2,810 a month and escalate to $3,256 in the fifth year.
For consumers, that likely means that they are paying a premium over renting or buying a typical home. Monthly payments on a 30-year conventional mortgage on the same house would be around $1,800.
The total cost of ownership would be closer to $2,400 after adjustments, but the rent is still $400-$500 higher on a monthly basis than buying. Paying that kind of rent premium on top of an inflated resale value, and the renter is stuck in circumstances where they spend so much on rent to obtain the option to buy that they can’t save for a down payment and close the deal.
Home Partners officials say that the increases are in line with the rapid rise in home prices in markets such as California and rents are typically within 5% to 10% of comparable properties in the market.
This is a feeble justification for what they know is a ridiculous markup. Many of these deals will fail because when the time comes to close the sale, many buyers will see they can get a lot more for their money if they buy something else. Most of these homes will become permanent rentals.
Tiffany Morgan, who works in marketing in Sugarland, Texas, turned to Home Partners 2013 after a divorce destroyed her credit. When she first heard about the program, she thought it was a scam. “I thought no way…it’s some scheme that I’m going to fall into,” said Ms. Morgan, who is in her mid-30s with a 7-year-old son.
Home Partners purchased the home for around $205,000 and she rented it for about a year for $1,730 a month. That same year she improved her credit and bought the house for $215,000. She thought, “What’s the worst case? I’ll lease it for a while and then if I fall in love with it I’ll do what I need to do to make it happen.”
The instinct people have to save what they perceive to be their family home was apparent during the housing bust. Even if the house is worth far less than the bank loan and the “owner” has no equity claim to the premises, people will enter into extremely unfavorable financial arrangements just to “keep their homes.” The rent-to-own model offers profits to investors by taking advantage of the emotional drives of prospective renter-owners.[dfads params=’groups=4&limit=1&orderby=random’]
Whether rent-to-own will prove to be profitable remains to be seen. A number of companies that rent out single-family homes have found that few renters have become buyers, either because they haven’t been able to restore their credit or haven’t been able to save enough for a down payment. But Home Partners said its credit screening targets middle-class and affluent clients who have steady jobs and an overall financial history that makes it likely they will be able to repair their credit and save money for a down payment within a few years.
Realistically, the number of people who travel this route to home ownership will be low.
First, many won’t succeed in repairing their credit, as some people never develop this level of personal responsibility. Those that don’t repair their credit won’t qualify for a loan, and they won’t buy the property.
Second, many won’t save for the down payment. I wrote a post on How to save money for a down payment to buy a house, but many don’t know and won’t learn the tricks to saving large sums. This problem is made worse by the large rental premium rent-to-own buyers are asked to pay.
Despite these problems, this is a viable path to home ownership, and for some people, it may be the only path.